Total time: 12:11

Andy Poreda: Hello everyone and welcome to Sage’s Hitchhiker's Guide to ESG investing. I'm Andy Poreda, ESG Research Analyst here at Sage, and I'm going to be discussing with our Chief Investment Officer Bob Smith about a recent issue that came up when the Department of Labor introduced a proposal that focused on how to address ESG investing. I think it's a very interesting topic, but I have some concerns, and I'm really excited to talk with Bob. I think he's going to give us some good insight as to what this means and how we can move forward kind of addressing this really important topic. Bob, welcome today. Can you give some intro on kind of your thoughts and kind of what you saw with this Department of Labor (DOL) proposal—kind of give people just a brief overview of what was discussed and kind of what your general thoughts are just on the intro of the topic.

00:51

Bob Smith: Sure. Good morning, Andy. And good morning, everybody else who is listening. Well, as you know, on June the 23^rd, the Department of Labor issued a notice of proposed rulemaking entitled “Financial Factors in Selecting Plan Investments.” And it was primarily aimed at clarifying the obligations related to the consideration of environmental, social, and governance factors by fiduciaries who oversee private sector pension and defined contribution plans that are guided by ERISA (The Employee Retirement Income Security Act of 1974). Despite the aim of providing clarity for ERISA fiduciaries, in our view, the proposal creates confusion. This is because there appears to be in part, a failure on the part of the DOL to distinguish the difference between ESG integration and economically targeted investments (ETIs). And so, you know, we think that the proposal says that ERISA fiduciaries are obligated to integrate ESG factors in their investment analysis. That's great—if they determined that those factors were likely to have a material economic impact on the investment. However, they then go on to say, if a fiduciary does not believe that ESG factors will have a material economic impact on the investment, it will not be permitted to consider those factors. This was very confusing. Should I or should I not bother?

2:27

Andy Poreda: Oh, can I jump in on that one? So, I guess the question is you know, we at Sage look at social impact and ESG risk as sometimes intertwined. So, I feel like there are some kind of combinations of the two and I don't know if they really get into the nuances of ESG investing, which is not always a one size fits all proposition.

2:48

Bob Smith: You know, the problem though, with this, this kind of pronouncement, this attempt to change the law basically says that fiduciaries, ERISA fiduciaries, may not sacrifice investment returns or assume greater investment risks as a means of “promoting collateral social policy goals.” But that statement in and of itself, in the pronouncement reflects their very erroneous understanding of the true and evident benefits that do accrue from good, solid core quantitative ESG risk analysis that will accrue to ERISA plans and to plan participants over the long term. And so, you know, we think it's a very confused proposal. We think that they are behind the curve in terms of understanding the true nature and value and effort that's really been put into quantitative ESG risk assessment, and how it's become a much more pivotal and cornerstone factor for a lot of investment managers around the globe.

03:59

Andy Poreda: Do you think it's going to scare off potential people that are interested in ESG? That’s my kind of big fear, that this convoluted message at a minimum is going to kind of give people pause on things, whether it's putting an ESG product onto their 401(k) platform, or it's a consultant considering for their ERISA plan, whether or not they're going to actually, you know, choose ESG investment.

04:23

Bob Smith: Look, aside from the fact that the statement says, look, we at the DOL are ignorant of, you know, the demonstrated benefits of ESG integration as a risk mitigation and the return enhancement effort. But they essentially tried to trivialize it or marginalize it in the sense that they're saying, look, you know, ESG really boils down to nothing more than having a collateral social policy goal, and nothing could be further from the truth. I think from a fiduciary standpoint, they put some fear into the marketplace, because now fiduciary duty within the context of ERISA relates to someone who has to manage people's money and how they should act in terms of the interest of plan beneficiaries. It means basically, you know, they have to serve the interests of the investors as opposed to themselves. That's the most important feature of the law—a firm adherence to client loyalty and prudence. And so, we don't see that ESG in any way, shape, or form violates the interests of the fiduciary standing. But also, you have to be able to consider all risks, particularly ESG focused risks, and apply good judgment and objective analysis. And in the pursuit of what we believe is really important, and what I think a lot of investors are looking for is: good, moral, ethical and prudent decision making—that really kind of bubbles up from this process. And this guidance, this proposal is, in my view, is essentially putting it into a kind of a secondary or tertiary position, in essence making ESG analysis kind of a second-class citizen in terms of the order of importance.

06:08

Andy Poreda: Yeah, I think Bob, that's really interesting. I think, you know, a lot of the work we've done here, whether it's looking at a company like 3M, which, you know, if we had done ESG analysis back on 3M, back in the 1950s and 60s, we would see what that damage is doing to our society, as well as the potential of that company moving forward can be in the essence of billions of dollars, right. I guess I'm confused as to why, you know, with these plethora of stories that we have, why is the Department of Labor still pushing back when more than ever I mean, even this market dislocation in March, we should be having a consensus that ESG analysis has been underutilized in the past and there is a place for it and a need for it more so than ever.

06:50

Bob Smith: Well, I think the DOL is misinformed. Their position doesn't necessarily reflect what is going on in the marketplace. When you look at the growth and the interest in ESG-focused and optimized funds, whether it's in the mutual fund community or in the exchange traded fund community, across the board in institutional investment management, this proposal seems to deny the clear trends that are in the marketplace. And more importantly, if we look at it from a 401(k) perspective, if you look at where you know, our workforce is demographically, we have a number of people within the workforce that are very environmentally sensitive, are very socially aware, you know, and recognize good deeds when they see them and good governance when they see them and they are very desirous of these of these values. It's not just the millennials, it's the X generation and more importantly the Z generation. They are going to constitute the largest segment of our workforce, you know, at 2025 and beyond. And yet we have a system that's really wired and built and oriented towards the Boomer generation. And if you think about it, what this particular proposal does—it’s an attempt to essentially push ESG back, to reduce its value, and to not give recognition for these trends. In fact, it denies the obvious—the consumer. What the consumer wants, and who that consumer is, is denied by this proposal. More and more millennials and Z generation, X generation people, are highly charged over these issues and want to see it infused in their investments that they decide upon. It also denies the idea that look, yeah, ESG funds are absolutely superior in their performance, particularly over the last two, three, four, or five years. They've done extremely well compared to a lot of conventional funds. So, what is the prudent choice? Is a prudent choice to pick the best funds that are being run in the best way, with the best outcomes? If that’s clearly the case, and that's what your fiduciary should be charged with doing, then why not ESG optimized funds? Because they stand head and shoulders above a lot of the conventional alternatives that are in the plan design, as it is today.

9:22

Andy Poreda: I guess the question is one, what happens next, with this seemingly kind of, you know, the DOL seems like they're on their own on this one in terms of how people view this. And then like, what else do you think we can do to help push the cause to make sure that the DOL changes their viewpoint, since this obviously seems like a very dangerous proposal that, you know, has a lot of long lasting consequences?

9:45

Bob Smith: I think that as we go forward, the way you evoke and you enforce change, is that you make your position known. This proposal is exactly what it is. It is a proposal. It needs public commentary. We need to change the mind at the DOL through our voice, our engagement. And it's an imperative that all advisors who see the value of ESG integration as a risk mitigation effort, who see the value of ESG as really getting at the heart and soul of what investors want in terms of their investment products that they're investing in, who see the positive intentionality that accrues on that in terms of the corporate management's that are receiving the benefit of the capital flows from 401k plans—those are the change agents. We want to get the DOL on board with being a change agent, the only way we do that is become engaged and make yourself known. Otherwise we will be stuck, you know, in the bygone era of how DC plans (defined contribution plans) should be run for the past, not for the future.

11:01

Andy Poreda: Wow, that’s some great insight. You know, I think we're all you going to be watching it with a close eye but we really appreciate you listening in today on Hitchhiker's Guide and hope you tune into our next episode.

11:12

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